How Not to Read Bonds — Aditi Bagchi

In 2001, Argentina defaulted on about $92 billion worth of bonds. It subsequently restructured these bonds, and 93% of bondholders accepted the 30 cents on the dollar that Argentina offered. But some hedge funds bought the original bonds at a discount and held out on repayment. They were able to persuade Judge Griesa in New York that a pari passu clause in the original bonds prohibited Argentina from treating new bonds differently than the original bonds, and the judge actually issued an injunction prohibiting Argentina from making payments on the new bonds – effectively locking Argentina out from capital markets.

Last week, Judge Griesa changed his mind. Or rather, he has reconsidered because a new government in Argentina is interested in making a deal with the holdouts. (Of course, the earlier government was also prepared to settle the outstanding bonds – just not on terms that the holdouts would accept, or that Judge Griesa found acceptable.) Judge Griesa will lift the injunction if the government settles with some of the holdouts. If Argentina settles with some holdouts and the injunction is lifted, the remaining holdouts will have little remaining leverage. So they seem likely to reach a deal within weeks as well. (See here for more background.) It looks like a win for Argentina: It will not pay face value of the old debt.

But this is no win. Argentina will be paying the holdouts about five times as much as it paid those who participated in the debt restructuring, and its economy has obviously suffered as a result of its shut out from capital markets.

The result of this series of events has been to massively reward hedge funds who bought debt on which Argentina had already defaulted. Their gain came at the expense of not only Argentina’s citizens but also other holders of its debt.

If the pari passu clauses on which the hedge fund’s legal strategy were truly unambiguous in their implications, there would still be a question as to whether a US federal court ought to play the role it ended up playing. But as it was, the pari passu clause had been historically intended for other purposes and the hedge fund’s argument that it barred payment on new debt issued by Argentina was novel.

Should a court interpreting such a clause take into account the context of the dispute? Argentina’s contracts with the hedge funds were not isolated transactions. The interests of many third parties, other holders of Argentina’s debt as well as participants in the broader market for sovereign debt, were at stake, even if we assume for these purposes that the interests of Argentina’s people are subsumed under the interests of the state.

In such circumstances, it was almost surreal for a court to infuse very general language with a specific meaning detrimental to the public interest. It is of course now in Argentina’s interest to settle with the hedge fund holdouts. But given that one of the essential functions of contract law is to minimize the opportunity for holdup, it is especially sad to see that it was an exercise in contract interpretation gone awry that allowed this game of hold up to end so profitably.

For a more in-depth discussion of when, how and why third party interests should be taken into account in contract interpretation, see my article Other People’s Contracts,32 YALE J. ON REG. 211 (2015).